Canada's central bank says economy worsening

The Canadian economy is deteriorating faster than projected and short-term interest rates may need to be cut again in an effort to boost activity, Bank of Canada governor Mark Carney said Wednesday.

Carney signaled that the central bank may reduce short-term interest rates again on Dec. 9.

"Despite having already cut official interest rates in half over the past year and having a financial sector that is still functioning effectively, some further monetary stimulus will likely be required to achieve the inflation target over the medium term," he said in notes from a speech delivered to a business audience in London, England.

Carney did not predict Canada would fall into a recession, defined as two consecutive negative quarters of growth. But he said the economy was weaker than the central bank's projections last month when it forecast a fourth-quarter contraction and meager 0.6 percent growth in 2009.

Recently, the International Monetary Fund downgraded Canadian growth to 0.3 percent next year, while several private-sector economists have predicted the economy will shrink in 2009 for the first time in 17 years.

Carney credited Canada's sound banking practices for sheltering the country from the worst of the financial crisis, but added that the country is taking a hit from the global slowdown and deep slump in the United States.

Carney said that along with falling commodity prices and a lack of available credit, Canadian exports of lumber, vehicles and parts have been hit hard.

"Thus, while domestic demand in Canada remains relatively healthy and the depreciation of the Canadian dollar will offset some of the declines in external demand, the risks to growth and inflation ... appear to have shifted to the downside."

Carney, while discussing how countries with strong economies like Canada were helpless to fend off the carnage from the breakdown in U.S. and global financial markets, said that many countries must now reform their systems. He added that the international community needs more vigilant international institutions to monitor systemic risk, noting that the crisis developed in part because of a lack of effective international surveillance.

He said Canada's experience with strong asset-to-capital ratios, less securitization of mortgages, and mandatory insurance on risky mortgages shows that reforms urged at recent meetings of G7 and G20 leaders would work.

As such, Carney argued against some reform suggestions for a complete overhaul of the Breton Woods institutions, such as the IMF and World Bank, that have regulated international commerce since the Second World War.

Nor should policy-makers jump to regulate salaries and bonuses in the financial sector, said Carney, whose background is as an investment banker at Goldman Sachs.

He suggested central banks may have to inject enough liquidity to get key markets such as interbank lending and commercial paper working again.